China’s call for global currency and who said what?

China called for the creation of a new currency to eventually replace the dollar as the world’s standard, proposing a sweeping overhaul of global finance that reflects developing nations’ growing unhappiness with the U.S. role in the world economy.

The unusual proposal, made by central bank governor Zhou Xiaochuan in an essay released Monday in Beijing, is part of China’s increasingly assertive approach to shaping the global response to the financial crisis.

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Mr. Zhou isn’t the first to make that argument. “The dollar reserve system is part of the problem,” Joseph Stiglitz, the Columbia University economist, said in a speech in Shanghai last week, because it meant so much of the world’s cash was funneled into the U.S. “We need a global reserve system,” he said in the speech.

Dr. Krugman says China is stuck with dollars and now is looking for easy way out.

The big news last week was a speech by Zhou Xiaochuan, the governor of China’s central bank, calling for a new “super-sovereign reserve currency.”

The paranoid wing of the Republican Party promptly warned of a dastardly plot to make America give up the dollar. But Mr. Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.

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Two years ago, we lived in a world in which China could save much more than it invested and dispose of the excess savings in America. That world is gone.

Yet the day after his new-reserve-currency speech, Mr. Zhou gave another speech in which he seemed to assert that China’s extremely high savings rate is immutable, a result of Confucianism, which values “anti-extravagance.” Meanwhile, “it is not the right time” for the United States to save more. In other words, let’s go on as we were.

That’s also not going to happen.

The bottom line is that China hasn’t yet faced up to the wrenching changes that will be needed to deal with this global crisis. The same could, of course, be said of the Japanese, the Europeans — and us.
And that failure to face up to new realities is the main reason that, despite some glimmers of good news — the G-20 summit accomplished more than I thought it would — this crisis probably still has years to run.

China’s 2007-2008 bet on global equities and riskier bonds likely cost it north of $50 billion — it all depends on exactly how much of its portfolio it put into risk assets. To be sure, it is in far better shape than Ontario Teacher’s Pension Plan, which lost a staggering 40% on its fixed income portfolio. Most of China’s reserves were in safe government bonds, and those bonds increased in value over the course of the crisis. But as Arvind Subramanian notes, China’s currency losses will eventually dwarf its equity market losses.

Those losses shouldn’t be a surprise. Currency losses on unneeded reserves are the price a country pays for subsidizing its exports with an undervalued exchange rate. But that doesn’t make it any easier to accept the losses – or to handle the inevitable argument that China’s leaders squandered China’s reserves.

China’s leaders are setting the stage to argue that these losses are the fault of bad US policies. They aren’t. They are the result of China’s own policy choices. Subramanian correctly observes “[China] is seeing itself as the victim of the dollar standard when it has been, for a long time, a beneficiary and promoter of this standard.” China’s leaders, though, have no incentive to recognize this.

But even if China didn’t explicitly plan to build up to many reserves, it now has them — and China’s leaders are no doubt interested in using them to increase China’s influence.

It isn’t hard to think of creative ways China could use its reserves to increase its global position. China alone could provide all the extra $500 billion the IMF now needs if it wanted to do so. Or it could set up a Chinese monetary fund to compete with the IMF.

To date, China has been fairly cautious, generally turning down countries that trekked to Beijing to appeal for emergency loans – though the recent expansion of RMB swap lines suggests that China may now be willing to take more risks. One potential problem: China would need to explain to its own citizens why it is using its reserves to help other countries rather than doing more at home.*

And then there is the elephant in the room: Will China’s large dollar holdings — and the fact that is is now the United States largest creditor — give it any influence over US policy?

No matter how this whole situation turns out, what China is going to do with its massive dollar reserves will decide the future of the US, the world financial system and US-China relationship. A lot depends on how China behave from here on.

About

08 November 2008
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It’s 08Nov08 today. The financial crisis, which started with housing meltdown in US, has unfolded itself massively on global scale. This diary is an attempt to present the events as and when they happen from now onwards. I will try to keep it as factual as possible and looking to update it at least once in a week.
I am not an economist, so hoping to get layman’s common sense perspective on events of the crisis.
Crisis Diary as it unfolds …